[Infowarrior] - Big Banks Mask Risk Levels

[Richard Forno]

(I'm reminded of the Captain Kirk response to Spock, asking him to  
negotiate a treaty with the Klingons:  "But you can't TRUST them!."   
---rick)

Big Banks Mask Risk Levels
Quarter-End Loan Figures Sit 42% Below Peak, Then Rise as New Period  
Progresses; SEC Review

By KATE KELLY, TOM MCGINTY and DAN FITZPATRICK

http://online.wsj.com/article/SB10001424052702304830104575172280848939898.html

Major banks have masked their risk levels in the past five quarters by  
temporarily lowering their debt just before reporting it to the  
public, according to data from the Federal Reserve Bank of New York.

A group of 18 banks—which includes Goldman Sachs Group Inc., Morgan  
Stanley, J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup  
Inc.—understated the debt levels used to fund securities trades by  
lowering them an average of 42% at the end of each of the past five  
quarterly periods, the data show. The banks, which publicly release  
debt data each quarter, then boosted the debt levels in the middle of  
successive quarters.

Excessive borrowing by banks was one of the major causes of the  
financial crisis, leading to catastrophic bank runs in 2008 at firms  
including Bear Stearns Cos. and Lehman Brothers. Since then, banks  
have become more sensitive about showing high levels of debt and risk,  
worried that their stocks and credit ratings could be punished.

That practice, while legal, can give investors a skewed impression of  
the level of risk that financial firms are taking the vast majority of  
the time.

Major banks masked their risk levels during the most recent five  
quarters by lowering debt levels just before announcing quarterly  
earnings, according to data from the New York Federal Reserve Bank.  
Kate Kelly and Evan Newmark discuss.

"You want your leverage to look better at quarter-end than it actually  
was during the quarter, to suggest that you're taking less risk," says  
William Tanona, a former Goldman analyst who now heads U.S. financials  
research at Collins Stewart, a U.K. investment bank.

Though some banks privately confirm that they temporarily reduce their  
borrowings at quarter's end, representatives at Goldman, Morgan  
Stanley, J.P. Morgan and Citigroup declined to comment specifically on  
the New York Fed data. Some noted that their firm's financial filings  
include language saying borrowing levels can fluctuate during the  
quarter.

"The efforts to manage the size of our balance sheet are appropriate  
and our policies are consistent with all applicable accounting and  
legal requirements," a Bank of America spokesman said.

Masking Risk
See the net borrowing of securities such as U.S. Treasurys or  
corporate bonds as pledged as collateral on the repo market.


An official at the Federal Reserve Board noted that the Fed  
continuously monitors asset levels at the large bank-holding  
companies, but the financing activities captured in the New York Fed's  
data fall under the purview of the Securities and Exchange Commission,  
which regulates brokerage firms. The New York Fed declined to comment.

The data highlight the banks' levels of short-term financing in the  
repurchase, or "repo," market. Financial firms use cash from the loans  
to buy securities, then use the purchased securities as collateral for  
other loans, and buy more securities. The loans boost the firms'  
trading power, or "leverage," allowing them to make big trades without  
putting up big money. This amplifies gains—and losses, which were  
disastrous in 2008.

According to the data, the banks' outstanding net repo borrowings at  
the end of each of the past five quarters were on average 42% below  
their peak in net borrowings in the same quarters. Though the repo  
market represents just a slice of banks' overall activities, it  
provides a window into the risks that financial institutions take to  
trade.

The SEC now is seeking detailed information from nearly two dozen  
large financial firms about repos, signaling that the agency is  
looking for accounting techniques that could hide a firm's risk- 
taking. The SEC's inquiry follows recent disclosures that Lehman used  
repos to mask some $50 billion in debt before it collapsed in 2008.

The practice of reducing quarter-end repo borrowings has occurred  
periodically for years, according to the data, which go back to 2001,  
but never as consistently as in 2009.

The repo market played a role in recent accusations leveled by an  
examiner in Lehman's bankruptcy case. But rather than reducing quarter- 
end debt, Lehman took steps to hide it.

Anxious to maintain favorable credit ratings, Lehman engaged in an  
accounting device known within the firm as "Repo 105" to essentially  
park about $50 billion of assets away from Lehman's balance sheet,  
according to the examiner. The move helped Lehman look like it had  
less debt on its books, the examiner said.

Other Wall Street firms, including Goldman and Morgan Stanley, have  
denied characterizing their short-term borrowings as sales, the way  
Lehman did in employing Repo 105. Both of those firms also make  
standard disclaimers about debt.

For instance, Goldman disclosed in its 2009 annual report that  
although its balance sheet can "fluctuate," asset levels at the ends  
of quarters are "typically not materially different" from their levels  
in the midst of the quarter. Total assets at the end of 2009 were 7%  
lower than average assets during the year, the report states.

Some banks make big trades that don't show up in quarter-end balance  
sheets. That is what happened recently at Bank of America involving a  
trade designed to mature before the end of 2009's first quarter,  
people familiar with the matter say.

Two Bank of America traders bought $40 billion of mortgage-backed  
securities from clients for one month, while at the same time agreeing  
to sell the securities back before quarter's end, according to people  
familiar with the matter. This "roll" trade provided the clients with  
cash and the bank with fees.

Robert Qutub, then Bank of America's chief financial officer for  
global markets, told Michael Nierenberg, a former Bear Stearns trader  
who oversaw the traders who made the roll trade, to cap the size of  
the short-term transaction, people familiar with the matter say.

A week later, however, the amount tied to the trade shot up to $60  
billion, these people say, before dropping to $25 billion, one of  
these people said, appearing to some at headquarters that the group  
had defied the order to cap the trade.

A bank spokeswoman said "the team was aware of and worked within its  
risk limits."

Write to Kate Kelly at kate.kelly at wsj.com, Tom McGinty at tom.mcginty at wsj.com 
  and Dan Fitzpatrick at dan.fitzpatrick at wsj.com